Act now—and you may be able to lighten both your 2020 and 2021 tax bills.
Jordan Sprechman, Vice Chairman, Practice Lead, U.S. Wealth Advisory
Tom McGraw, Managing Director, Head of Tax Planning, Advice Lab
Amanda Lott, Executive Director, Head of Goals-Based Planning
Most people have happily said goodbye to 2020—the year of a raging coronavirus plague and lockdowns across the globe. But tax planners know there’s still time to make 2020 a little bit brighter on the financial front, and early in 2021 is a great time to get started on making the most out of this year.
So we suggest you welcome meeting with your tax advisors to prepare your 2020 returns. This will be your opportunity to discuss with them your needs, and which of these 12 potential actions might suit your situation and enhance your financial life.
What might you do now about 2020?
Here are four actions to consider related to your 2020 tax returns. Which work for you?
Contribute to IRAs
With a traditional IRA, you can contribute up to $6,000—or if you were 50 years or older in 2020, up to $7,000 of your earned income. Moreover, those contributions are potentially deductible.
With a Roth IRA, you can make non-deductible contributions up to the same limits for 2020 with the benefits that all growth, and future distributions, will be tax-free.
If you own a business that offers SEP or SIMPLE IRAs to employees, you have a grace period for making contributions to those accounts, based on the due date of the business’s or employer’s tax return, including extensions.
Invest in an Opportunity Zone Fund (QOF) to defer realized gains
Have you directly (or indirectly, through a pass-through entity such as a partnership) realized short- or long-term gains during the last few months of the year on the sale of an asset? If so, you may have 180 days from the date of that realization (as determined under special QOF rules) to invest those gains in a QOF and defer (perhaps for five or more years) payment of taxes that would otherwise be due.
Even better, the Internal Revenue Service just announced an additional grace period for any taxpayer whose 180-day investment period would have ended anytime after April 1, 2020, and before March 31, 2021. They now have until March 31, 2021, to reinvest those proceeds into a QOF.1
Note that even if a pass-through entity sold an asset early in 2020, its date of realization for that sale may be deemed to be either the end of the partnership’s tax year (generally December 31) or its year-end partnership tax filing due date (March 15). You should talk to your tax advisor to determine what the relevant date of realization is and how to measure the 180-day period in your particular circumstances.
Distribute trust income
Trustees have until March 6, 2021, to make income distributions to beneficiaries and have those distributions treated as if they were made in 2020.
If a trustee has discretion over whether to make a distribution, the decision of whether to do so must be informed, always, by (a) the terms of the trust, (b) the trust’s income and transfer tax characteristics, and (c) the best interests of the beneficiary.
Only after weighing those factors should a trustee determine whether a distribution would make economic sense, as it often does. The marginal U.S. income tax rate of many trust beneficiaries (including even some whose income exceeds $500,000) is well below the top 37% tax rate. However, that top rate applies to all income in excess of $12,950 accumulated by a non-grantor trust.
Seek a “SALT refund” for your pass-throughs
The IRS issued a Notice on November 9 stating it intends to issue regulations saying pass-through entities (e.g., partnerships and S corporations) are exempt from the $10,000 deductibility cap on state and local taxes (SALT) at the entity level. You therefore may be able to apply for refunds for the tax years beginning January 1, 2018, when the SALT deductibility cap generally became effective.
How will you pay your tax bill by April 15?
While tax returns are often filed on extension, tax payments must, in all but the rarest of circumstances, be made by April 15. So you may want, or need, to raise cash to make that payment. If that’s the case, what are your options?
Should you borrow to pay taxes or sell select holdings?
Borrowing against your portfolio of marketable securities is a handy solution. Of course, borrowing has a cost. However, with interest rates so low right now, that cost is relatively small and may be far outweighed by other considerations (such as not having to sell securities or other assets you’d prefer to hold onto now).
Note: The interest on funds borrowed to pay taxes is not deductible, while interest on funds borrowed to invest is. So, you might want to borrow to invest and deduct the interest paid on those borrowings, using cash from other sources to pay your taxes.
If you don’t want to borrow, you can review your holdings, and if your portfolio had both gains and losses, consider selling those holdings that produced no net capital gains, and using the proceeds to pay the taxes due.
What can you do to make 2021 better?
There are some issues and opportunities particular to this year that you may want to consider as soon as possible:
Think about required minimum distributions (RMDs) and qualified charitable distributions (QCDs)
RMDs were suspended in 2020 due to the pandemic, but it looks like they’ll need to be made in 2021.
However—before you take your RMDs this year—determine whether you’re eligible, and if you are, whether you’d want instead to make a QCD of up to $100,000 to a public charity, in place of all or part of your RMDs. Unlike an RMD, the QCD amount is excluded from your gross taxable income.
Two notes: The QCD is not counted as an income tax charitable deduction. Also, the QCD cannot be made to either a donor-advised fund (DAF) or a private foundation (operating or non-operating).
Take advantage of greater charitable deductions available for 2021
Thanks to special legislation, you are allowed to donate up to 100% of your adjusted gross income (AGI) to a public charity in 2021, as you were able to do in 2020. Previously, that AGI limit was 60%.
Note: These donations cannot be made to DAFs.
However, you can combine your use of this provision with other donations, which are subject to other limitations (such as the 30% AGI ceiling on donations of appreciated publicly traded stock to public charities), to still achieve 100% deductibility of your 2021 AGI. To do so would require thoughtful alignment of the assets to be donated, and the receiving entity (including possibly your DAF account).
Review your quarterly estimated payments
Review your actual 2020 and anticipated 2021 tax bills to determine your minimum necessary quarterly estimated payments for this year.
If you are expecting outsized amounts of income in 2021, you may want to rely on the actual payments you made in 2020 to determine the estimated payments you make in 2021. You may be allowed to do so under the so-called “110% prior year safe harbor rule.” And this way you can keep more of your income, without worrying that the IRS will charge interest and impose penalties, until April 15, 2022.
Evaluate your home state
Figure out what state you plan to consider as your residence for income tax purposes in 2021. Many taxpayers moved due to the pandemic, but were not able to adjust their lifestyles sufficiently in 2020 to get themselves considered residents of a lower-tax state, or at least minimize taxes owed to multiple states. You have more time now to establish domicile in the state to which you want to pay taxes this year. It may be easier to switch where trusts that you’ve created are sited; so don’t forget to review those as well.
Be aware of potential federal income tax rate increases
It’s expected that Congress will consider and possibly pass legislation raising some rates for 2022. Such potential rate hikes are unlikely to apply retroactively to January 1, 2021. They also are unlikely to impact individuals with incomes less than $1 million a year. See What do President Biden’s priorities mean for you?
However, if you’re anticipating that tax rates will go up effective January 1, 2022, you may want to consider recognizing income and gains in 2021.
Optimize your annual exclusion gifts
Consider making annual exclusion and similar gifts earlier in the year, so that any growth on these assets over the course of the year would not ultimately be subject to estate tax in your estate.
Harvest capital losses
Consider implementing a systematic capital loss harvesting program for securities portfolios. That would allow you to take advantage of any market drawdowns while avoiding the (adverse to taxpayers) wash sale rules—and bank those losses to be utilized against already realized, or future, capital gains.
We can help
There are many legitimate ways to reduce the taxes you’ll be obligated to pay for 2020 and 2021. Your J.P. Morgan team would be honored to work with you and your tax advisors to make sure that your decisions on these matters support your wealth plans and your values.
*This is relevant for U.S. clients.
1Source: Notice 2021-10, 2021-6 IRB.
